Analysis: Drought dampens Jana's case in Agrium fight

(Reuters) - If Jana Partners fails in its bid to shake things up at Canada’s Agrium Inc (AGU.TO), the New York hedge fund can always blame the weather.

The hedge fund bought into Agrium - the biggest U.S. farm products retailer and a major fertilizer producer - just before the worst U.S. drought in a half century sent grain prices surging. Jana, Agrium’s largest shareholder and known for its aggressive actions as an activist investor, wants the company to boost shareholder value by spinning off its retail arm.

But the jump in grain prices has already sent shares of Agrium surging, making Jana’s argument for a spin-off much less compelling. Investors have less reason to question Agrium’s position that the retail unit is more valuable within the company than outside it.

The drought is expected to keep grain prices high into next spring’s North American seeding period and beyond. That bodes well for sales of fertilizer, seed and chemicals to farmers eager to tap high grain prices.

So even if the dry weather dents Agrium’s retail earnings in the short term, its wholesale business will do just fine.

The drought “leaves them in a great position,” said a shareholder who asked not to be identified. “They make the stuff and they sell it directly to the farmers. They’re in the sweet spot right now, and it could last for several years.”

After listening to Jana’s pitch last week for spinning off the retail operation, the shareholder is unconvinced the plan would produce a greater return.

Other investors also said they are not persuaded, and the trend in Jana’s shares since the hedge fund on August 14 disclosed that it had become Agrium’s biggest shareholder and was agitating for a breakup suggests that shareholders are lukewarm on the idea.

“The company has been superbly managed,” said Peter Letko, co-founder of Montreal-based Letko Brosseau Investment Management Inc., a significant Agrium shareholder in the widely held company with a 1.6 percent stake as of June 30.

Jana approached Letko last week with its case for breaking up Agrium, but the investor didn’t bite.

“It’s (had) a terrific performance, and it isn’t just because commodity prices are higher. They’ve acquired and managed and built a huge enterprise, and done it very well.”

Jana disclosed the purchase of more than 6.5 million shares of Agrium, or about a 4 percent stake, as of June 30. A source close to Jana said the hedge fund had since bought more to hold 5 percent.

Jana did not disclose what it paid for the shares, but prices in the quarter ended June 30 ranged from about $74 to $89 per share. Agrium shares on Tuesday closed at $98.89 on the New York Stock Exchange.

“This is not even a close call,” said a source close to Agrium. “This is not a conglomerate situation - this is a company that manufactures and sells crop nutrients.”

A retail spinoff “would be an orphan stock out there. It’s valuable inside of Agrium, not as a standalone company.”

Even if the retail arm went on the block, finding a buyer with the wherewithal to buy it might prove difficult. Agrium has a market capitalization of $15.9 billion, giving the retail arm a value of roughly $7 billion to $8 billion, based on forecasts for 2012 earnings before interest, taxes, depreciation and amortization (EBITDA).

PUSHING FOR CHANGE

Jana in the last year has made its mark as an aggressive investor. It took a strong role in lobbying for change at Dutch delivery company TNT Express TNTE.AS, with TNT ultimately agreeing to be acquired by UPS. It bought a stake in Marathon Petroleum Corp (MPC.N), calling the company undervalued, and talked with management on strategy, asset structure and buybacks. Marathon in February announced a stock buyback and said it was considering spinning off some assets.

It pressed McGraw-Hill Companies Inc MHP.N to restructure last year, and while McGraw-Hill initially balked at the hedge fund’s request to spin off a division it ultimately agreed. And in April Jana pushed for change at Barnes & Noble Inc (BKS.N) after acquiring an 11.6 percent stake.

Whether Jana will ultimately persuade Agrium to spin off the retail unit remains unknown, but so far with the rise in the share price it is making money anyway.

Since talks with Jana began in May, Agrium launched a big share buyback, partly meeting a Jana demand for greater shareholder returns. Sources close to Agrium insist the buyback had nothing to do with Jana.

A source close to Jana said the hedge fund also took comfort from the fact Agrium has not taken a hard line against Jana’s ideas about cutting the retail segment’s costs and improving its operating performance, and talks on that issue would continue.

“It’s just as important as the spin-off,” the source said.

MERITS OF JANA‘S CASE

Jana’s challenge to Agrium is the second major tussle between a Canadian company and an activist investor this year. In May, Bill Ackman’s Pershing Square Capital Management scored a resounding victory in a proxy battle that overhauled Canadian Pacific Railway Ltd’s (CP.TO) board.

There are differences. While CP’s share price stagnated for years until Ackman stepped in, Agrium’s stock has more than doubled over the last five years.

Shares of Agrium and CF Industries, North America’s two nitrogen fertilizer powerhouses, are both up some 50 percent this year.

But advocates of a spin-off point out that CF’s share price has quadrupled over the last five years, while Agrium’s shares have only slightly more than doubled.

During that time, Agrium has expanded its retail operation with big acquisitions across the United States, Australia and Canada, suggesting to Jana that the retail arm is holding back shareholder value, at least in comparison to CF.

Agrium may have undermined its own argument to hold onto the retail arm when it suggested this week that analysts gauge the unit’s value against the performance of a different set of companies than it previously used.

The change effectively resulted in Agrium assigning a lower value to the unit, measuring it by less than eight times forward EBITDA, rather than nine times.

“If Agrium wants to maximize shareowner value, a good first step might be to drastically step up disclosure,” CLSA analyst Mark Connelly said in a note to clients.

“If the business is as good as Agrium management told us it is, then there is a clear and compelling opportunity to share that news more effectively with investors, and drive the stock higher,” he said. “And if the story has gaps, Jana’s interest should hopefully bring management’s attention more clearly to closing them. Either way, investors win.”

Reporting by Euan Rocha in Toronto and Rod Nickel in Winnipeg; Editing by Frank McGurty and Leslie Adler